Research summary

Getting inside the Fed’s head

August 25, 2022

Scenario 1: A hard landing
Figure 1: The Fed could steer clear of a hard landing by pausing planned rate hikes

a. Policy turns out to be too restrictive, forcing the Fed to pause

A dotted line shows the expected trajectory of the federal funds rate, which rises to around 3.8% by the end of 2023 and then stabilizes at around 2.5% from the end of 2025. A solid line shows how the Fed might modify the expected trajectory in the federal funds rate, which rises to around 3.4% by the end of 2022 and subsequently declines to stabilize around 2% by the end of 2026.

b. Inflation falls faster than expected

A dotted line shows the expected trajectory of headline PCE, which declines from 6.3% in June 2022 to around 1.4% at the end of 2024 before moving back to stabilize around 1.5% by the end of 2026. A solid line shows how reaction by the Fed might result in headline PCE declining somewhat less, from 6.3% in June 2022 to around 1.1% at the end of 2024 before moving back up toward 2% by the end of 2028.

c. The Fed avoids a deep recession; it’s a moderate one instead

A dotted line shows the expected trajectory of the output gap, which declines to around –1.5% in 2024 and subsequently improving. A solid line shows how reaction by the Fed might result in the output gap declining more modestly to around –1.2% in 2024 and improving thereafter.
Scenario 2: Stagflation
Figure 2: Persistently high inflation could lead to more aggressive rate hikes and a severe recession

a. The Fed has to tighten more aggressively as it finds itself behind the curve

A dotted line shows the expected trajectory of the federal funds rate, which rises to around 3.8% by the end of 2023 and then falling to stabilize at around 2.5%. A solid line shows how the Fed might modify the expected trajectory in the federal funds rate, which rises to around 5.40% by the end of 2023 and subsequently declines to stabilize around 2.5%.

b. Inflation remains above target for longer

A dotted line shows the expected trajectory of headline PCE, which declines from 6.3% in June 2022 to stabilize at around 3.5% by the end of 2024. A solid line shows how reaction by the Fed might result in headline PCE declining more sharply, from 6.3% in June 2022 to stabilize at around 2% from the end of 2026.

c. This drives the economy into a severe recession

A dotted line shows the expected trajectory of the output gap, which declines to around 0.4% by the end of 2024 and improves thereafter. A solid line shows how reaction by the Fed might result in the output gap declining more modestly to around –1.2% in 2024 and improving thereafter.
Scenario 3: A softish landing
Figure 3: Favorable inflation and output data could allow the Fed to raise rates less than planned

a. The Fed can reverse some of the planned rate hikes

A dotted line shows the expected trajectory of the federal funds rate, which rises to around 3.8% by the end of 2023 and then stabilizes at around 2.5% from the end of 2025. A solid line shows how the Fed might modify the expected trajectory in the federal funds rate, which rises to around 3.4% by the end of 2022 and then declines to stabilize at around 2.5% from the end of 2025.

b. Inflation will converge toward target

A dotted line shows the expected trajectory of headline PCE, which declines from 6.3% in June 2022 to fall below target and then stabilize at around 2% from the end of 2027. A solid line shows how reaction by the Fed might result in headline PCE declining more slowly, from 6.3% in June 2022 to stabilize at around 2% from the end of 2024.

c. A recession can be avoided

A dotted line shows the expected trajectory of the output gap, which declines to around –0.9% by the end of 2024 and improves thereafter. A solid line shows how reaction by the Fed might result in the output gap declining more modestly to around –0.2% in 2024 and improving thereafter.
The path forward
Related links:

Contributors

Roxane Spitznagel
Vanguard Information and Insights

Get Vanguard news, insights, and timely analysis on the market, delivered straight to your inbox.

Read our privacy policy to learn about how we keep personal information private.

* Indicates a required field

Vanguard Information and Insights

Thank you for subscribing to Economics & markets.

You'll be notified when new content is published, but will only ever receive one email a day from Vanguard Insights.

Vanguard logo

Vanguard is the trusted name in investing. Since our founding in 1975, we've put investors first.